S&P downgrades BMO following commodities trading loss

LOSSES & LAWSUITS

The debt rating for the Toronto-based bank was cut to A+ from AA-, the credit-rating company said – the first S&P downgrade for the bank in 20 years.

"We believe the overall stature of the bank's risk governance in market risk is weak, and BMO must give thought to ways of strengthening this,'' S&P said in the statement.

In mid-May, S&P said it was reviewing the bank's operations after the lender reported pretax trading losses of CAD680 million ($641 million) from trading natural-gas options. The loss was equal to 12% of the bank's net income last year, and "does not reflect BMO's stated strategy of being a low-risk bank,'' S&P added.

According to a report on Bloomberg, BMO expanded trading in natural gas options after prices rose in 2005 following Hurricane Katrina. The bank relied on one broker to price contracts as the portfolio grew, resulting in an "inappropriate level'' of options that lost value when there was a decline in the volatility of gas prices, chief executive William Downe said to the wire service. "The steep level of loss was largely a result of incorrect valuation of the commodity portfolio, which masked the rapid escalation of risk and the real cost of the positions. Our commodity trading team did not operate according to standard BMO business practices. Leadership oversight of the business was not as disciplined or rigorous as it could have been,'' Downe added.

The last time S&P reduced the bank's rating was in May 1987, according to Bloomberg data. The downgrade puts BMO on a par with Canadian Imperial Bank of Commerce, with the lowest debt rating among Canada's five biggest banks.